"Austrian" Economic Forecasts Too Gloomy

Bill Conerly
, ContributorI connect the dots between the economy ... and business!Opinions expressed by Forbes Contributors are their own.

Many of my friends are influenced by the Austrian school of economics (not the same as the economics of Austria). I think they are way too gloomy in their economic forecasts. Though not a thorough-going Austrian myself, I read Human Action as a first year college student, kept reading the Austrians through graduate school, and even had dinner with Friedrich Hayek.

(It’s pretty weird that people who subscribe to the Austrian school would be forecasting at all. See my note on methodology below).

Austrian economics comes to strongly free-market conclusions. It would severely limit the role of government, keep taxes low, adopt the gold standard (or competing currencies), allow the price system to work without check. So when Austrians see our actual government at work, they think the world is going to Hell in a handbasket.

Here’s where they are wrong. The economy is resilient. People get up in the morning and try to improve their circumstances. They produce a few things they want themselves (maybe breakfast) and many things that other people want. They serve others in a selfish effort to obtain the things that other people produce. Although government interferes with those efforts, it usually does not totally eliminate productive activity. Individual initiative may be entirely stifled in North Korea, but that’s the exception rather than the rule.

The forecaster has to look at whether worsening government policy will outweigh productive activity by millions upon millions of people. There are three important questions.

“How big a problem is the government” is the first question. Although we see the government reducing the role of prices in some areas, such as health care, the price system is still working in many other areas of the economy. It is an entirely empirical question whether damage caused by bad policy will or will not be outweighed by improvements developed by enterprising people. It’s not enough to say, “The government is really, really big, and it’s really, really bad.” On the other side of the ledger is this: “People are really, really good at finding ways to produce valuable goods and services, and they are always getting better at doing so.”

“When will problems caused by government hit us?” The second question is about timing. We know that rent controls cause under-investment in apartments. But Austrian theory does not say whether the resulting shortage will be significant one week after rent controls are adopted, one year later, one decade later, or one century later. (See, for example, Human Action, p. 246.)

“How will people work around government policy?” The third question arises because profit-seeking people look for opportunities, which often entail going around the plans of bureaucrats. For example, advocates of gun control complained that the old assault weapon ban was easily circumvented by gun manufacturers who made cosmetic changes to satisfy consumer demands in spite of the law. Every law and regulation in the economy inspires a reaction. Some work-arounds fail to fully offset the government activity, but some completely offset, while others may trigger innovation that more than offsets the government taxes or regulations.

Could the extreme doom and gloomsters be right? Of course they could—it’s an empirical question. I fall back on years and years of experience watching doom and gloom forecasts fail. We survived the wild inflation ride of the 1970s. We survived Richard Nixon’s wage and price controls. We survived Jimmy Carter’s energy policy. I’m not totally sure how we’ll do it, but we’ll survive the current batch of bad policies, too. You can take the other side of the debate if you like, but you can’t claim that Austrian economics dictates a dismal forecast.

Note on methodology. The very label Austrian school was coined during a methodological debate over the use of statistics versus logic in economic analysis (the methodenstreit http://en.wikipedia.org/wiki/Methodenstreit>). The Austrians opposed quantitative analysis as a way to understand economics, and even to this day their writings tend to avoid the econometrics so common in modern economics.

Those of us in business, as well as those working in investments, need to make forecasts. I have argued with Austrian economists that profit-seeking businesses find it useful to use measures such as gross domestic product to understand the environment in which they operate. The most hard-core Austrians reject any measure of economic activity, probably because they are so afraid that governments will try to manipulate the economy. It’s a contradiction, I believe, to reject a tool that profit seeking people find useful.